Final "hot stock" regs, and Dunn Trust.

• Author: Steinmetz, Adam L.

In October, Treasury issued final regulations that deal with the application of the Sec. 355(a)(3)(B) "hot stock" rule (T.D. 9548). The final regulations replace temporary regulations, originally issued in December 2008 (REG-150670-07), without changes. The final regulations apply to distributions occurring after October 20, 2011.

Background

Sec. 355(a) provides that, under certain circumstances, a corporation (Distributing) can distribute stock and securities in a corporation that it controls (Controlled) to the shareholders of Distributing with no recognition of income, gain, or loss to the involved parties.

Pursuant to this general rule, a Sec. 355 transaction provides a mechanism for either: (1) the division of one corporation into two or more corporations; or (2) the division of an existing parent corporation from one or more subsidiary corporations in a wholly or partially tax-free transaction commonly referred to as a "spinoff" or "split-off." An example of a spinoff is where Distributing drops the assets of one line of business it operates into newly formed Controlled in exchange for stock of Controlled in a Sec. 368 type D reorganization. Distributing then distributes the stock of Controlled to the Distributing shareholders in a pro rata distribution, resulting in the same shareholders' owning stock directly in both corporations. A split-off involves the same facts, except that the stock of Controlled is distributed in exchange for certain Distributing stock, resulting in a separation of the shareholders between the two corporations.

A Sec. 355 transaction is a powerful tool that can provide a corporation with the means to separate lines of business or realign its ownership structure while deferring the recognition of income or gain. In an attempt to curb potential abuses in applying the Sec. 355 rules, numerous requirements, exceptions, and special rules in the Code and regulations create an extremely high standard that taxpayers must achieve for a transaction to qualify as tax free under Sec. 355. A nonexhaustive list of some of the more salient rules and requirements includes:

* Distributing must have Sec. 368(c) control (80% of all voting shares and 80% of each other class) of Controlled immediately prior to the distribution.

* Immediately following the distribution, both Distributing and Controlled must be engaged in a trade or business that has been actively conducted for at least five years prior to the distribution and that was not acquired by Distributing or Controlled during that period in a transaction that was taxable in whole...